English
Since the global financial crisis, private debt has emerged as a significant asset class in the global financial landscape.
As banks and public debt markets became skittish and their risk tolerance shrank, more companies have and continue to turn to private debt to meet their funding needs.
The size of the private debt (or private credit) market at the beginning of 2024 topped USD 1.5 trillion, up from USD 1 trillion in 2020, according to Morgan Stanley Investment Management, which expects it to reach USD 2.8 trillion by 2028.
It is a form of debt financing that takes place outside of public markets and outside the banking system, presenting opportunities for both investors doing the lending and borrowing businesses who are unable to obtain debt financing from traditional banks and public debt markets.
The lenders in these types of transactions tend to be asset management firms, private debt funds, private equity, venture capital firms, and even crowd-funding platforms, while the borrowers range from SMEs to large corporations and private equity funds.
Read more about: Islamic View of Debt, Lending & Borrowing.
Unlike public debt markets like the bond market, private debt is highly illiquid, making them tough to exit. Investors must expect to potentially commit the capital throughout the duration of the loan.
Private debt typically generates higher yields to compensate for the illiquidity and risk inherent in some forms private debt lending.
Private debt can be highly customizable, with debt that can be structured in a variety of ways, ranging from good old-fashioned lending with interest to deals that combine debt and equity, depending on the lender and borrower and their needs.
Private debt operates outside the confines for the heavily-regulated banking sector and its high capital requirements.
|
Feature |
Private Debt |
Public Debt |
|
Liquidity |
Highly illiquid
|
Very liquid
|
|
Lender |
Broad spectrum of investors |
Banks and large financial institutions |
|
Regulation |
Lightly regulated |
Heavily regulated |
|
Customization |
Highly customizable |
Standard instruments |
|
Transparency |
Limited |
Highly |
This is a loan provided by private creditors to companies (typically mid-market companies) for a set duration at an agreed upon interest rate and collateral, usually used to fund growth, acquisitions, or refinancing.
Combines debt and equity by giving the lender the right to convert debt to equity in case of a default. These typically offer higher yields as it is risky. Mezzanine debt holders are subordinate to standard lenders in the event of a default.
Similar to mezzanine financing and used typically to find startups, venture capitalist firms lend startups with equity stakes in the company as collateral, giving founders capital without necessarily giving up equity.
These are typically loans given to companies facing financial difficulties. Investors buy the debt at a discount and profit from the recovery or the restructuring.
Providing financing for property acquisition, development or refining, real estate debt includes things such as construction financing, bridge loans, and structured financing.
For investors: The biggest benefit to an investor is the higher yields than public market bonds. Private debt also provides them with predictable cashflows in the form interest payments.
The flexibility of the transactions allows them to play around with debt and equity to their benefit. Private debt is also relatively shielded from the swings of public financial markets, making them a safe haven and a form of diversification.
For the borrower: The biggest benefit to a borrower is that it offers them financing outside the traditional banking system which has cumbersome requirements.
Private debt also allows them the flexibility to structure the financing in a way that is beneficial to them and not as restrictive as banking loans. It is also much more expedient than a bank loan and it is not subject to public disclosure requirements.
Companies looking to borrow from private debt markets typically are unable or unwilling to meet the requirements of the banking sector, requirements which are meant to reduce the risk of default. This, coupled with potentially riskier deal structures, makes private debt inherently riskier.
Due to being less regulated than public markets, disclosure requirements aren’t as high, which could make transparency very limited and potentially causing challenges when managing the investment.
Investors cannot exit their position at will.
Read more about: Basic guide to Wealth Management
Disclamer:
This post is for educational purposes only, and the Firm does not directly or indirectly provide these services.
